Now that pension freedoms are with us, we have had a few enquiries about cashing in old defined benefit (final salary) schemes and transferring the money into a drawdown plan. As advisers, our initial reaction will be “No”, as it is hard to imagine too many circumstances where someone would be better off after plundering a final salary scheme.
Last week I saw a client, who had picked our name off the Unbiased website, (www.unbiased.co.uk), after a previous adviser had declined to complete a transfer without an explanation. The client had a final salary pension due to him of £7,000 a year, £35,000 in tax free cash, and a spouse’s pension with an increasing income of 2.3% per annum. He had been offered £210,000 as a lump sum to transfer it elsewhere and was sorely tempted. This would clear his mortgage five years early and settle his credit cards, leaving the bulk of the money to remain invested in a money purchase pension.
Before leaping to conclusions, let us think about the situation from the pension scheme’s point of view. Final salary schemes are a major uncapped liability for an employer, buying an annuity at the point of retirement to cover the pension scheme’s liability can be prohibitively expensive, so most pensions are paid from a mixture of investment returns and employer top-ups. Someone leaving the scheme for a fixed payment would be a good reason for a party; a fixed cap on costs for that member, especially if they leave for a discounted payment.
If you see the £210,000 as a bribe to leave the scheme, then the question becomes, “Is it enough?” Shoving the £210,000 through the Money Advice Service annuity comparator, (https://comparison.moneyadviceservice.org.uk/en/Annuity/Quotes), gives a likely income of £4,588 per annum, after taking tax free cash, spouse’s pension and escalation to match the final salary scheme, so I would suggest the bribe is too small!
Not only is the cash on offer insufficient, but it also would flag a massive transfer of investment risk to the client. If the client stays in the pension scheme, he is entitled to £7,000 plus a 2.3% increase a year, no matter what state the pension scheme is in. If things went badly, the scheme would have to be topped up by the ex-employer or if everything went wrong, by the Pension Protection Fund, (PPF). If he moved to a drawdown scheme, there are no guarantees and no protection; if he ran out of money, no one would come to the rescue.
After not much more than 10 minutes deliberation, he decided not to take the transfer, but to take the pension from his Normal Retirement Age.
So, given that most transfers from final salary to money purchase would be a grave mistake, under what circumstances would a transfer be appropriate? As many providers are insisting on formal advice before they will facilitate a transfer to a money purchase scheme and most advisers will charge for advice, whether it is followed or not; use this checklist to see if a transfer is feasible:-
1. You are in very poor health and would, most likely, die before receiving value from the scheme.
2. You are unmarried or otherwise would not benefit from the features offered by the existing scheme.
3. Your circumstances are such that taking cash now would be much more beneficial than staying in the scheme. Examples could include significant personal debt, potentially leading to the loss of your home, funding a divorce or to avoid a custodial sentence.
Just because you want too, will not be enough; most advisers will not wish to get involved in the transfer of defined benefit schemes to cash based schemes as the regulatory risk is so high. It is not unknown for clients who made a decision to cash in final salary schemes 10 years ago to seek compensation because their money has run out. For the adviser, this could present as a long drawn out professional suicide with a regulator who will show no mercy.
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The information contained is for guidance only and does not constitute financial advice. It is based on our understanding of UK legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change. Accordingly no responsibility can be assumed by Martin-Redman Partners its officers or employees, for any loss in connection with the content hereof and any such action or inaction.